529 plans and the best options for college savings
Q. About NJ’s 529 Plan: It doesn’t seem to be the greatest plan. Because I want no risk for my children’s college monies, what can you suggest? I just want a place, an account, where I can simply deposit, hopefully will grow something, tax free, to be used only for college expenses? Does that exist? Besides a bank account in their name?
— Need help
A. Your question is loaded with important considerations for any family that’s saving for college.
Let’s start with why 529 plans are so popular, and why a 529 plan could be appropriate for some families.
From a financial perspective, 529 plans offer tax-free growth when the funds are used for qualified educational expenses, said David Slater, co-founder of College Benefits Research Group (CBRG) in Roseland.
But, Slater said, 529 plans do not provide any investment guarantees.
“If you are in an age-based 529 plan, the investment portfolio should morph into a more conservative allocation as your kids approach college age, but the values are certainly not guaranteed,” Slater said. “Of course if the investments are in a totally conservative portfolio, then it is likely that there would be little to no growth, thereby negating any financial benefit.”
He said he’s seen investment allocations with significant risk while kids are in high school, which most reasonable planners would not find prudent, Slater said.
Now, you said you’re looking for no risk and tax-free growth.
Unfortunately, there is no free lunch when investing, said Taylor Thomas, a certified financial planner with Round Table Wealth Management in Westfield.
He said a “risk-free” return is generally pegged to the interest rate that can be earned on a 3-month U.S. Treasury Bill, which is currently about 0.34 percent, and even this is subject to the financial stability of the U.S. government, Taylor said.
“Simply stated, an investor will need to take on some amount of risk — the chance of losing principal — in order for the opportunity to make a return on his/her investment,” Taylor said.
But then the question becomes: how much risk should an investor take?
Taylor said the answer is not an exact science, but should rather be a combination of what return is needed to achieve the goal — in your case saving for college — and what amount of volatility you’re willing to assume.
He said a 529 plan would accomplish the goal of tax-free investment growth (assuming the withdrawals are used for qualified college expenses), but you need to review a few items before making an investment.
First, how old is the child who will use these savings?
“I would suggest that additional risk (stock/equity funds) should be added to the overall portfolio the further from college age the child is,” Taylor said.
That’s because in a recent survey of college pricing, the College Board reported that a moderate budget for public colleges is about $24,000 and about $48,000 for private colleges. If you factor in the rate of inflation on these costs (3-4 percent), many parents will need investment returns to help grow their contributions to college savings accounts to cover these costs, Taylor said.
Next, you need to see how much risk you’re willing to take.
“If the investor does not have tolerance for much risk, many 529 plans offer a conservative 100 percent fixed income allocation which, depending on the underlying investments, should be fairly stable in value even during stock market declines,” Taylor said. “It should be noted that this option may not keep up with the inflation on college expenses and thus the amount of savings to fund education will need to increase.”
Slater agrees that safety is key, and that money designated for college should not be put at risk as you near the time for your child to attend. He said savings accounts and Certificates of Deposit provide safety — but little growth — and they, like the 529 plans, need to be reported on financial aid forms like the FAFSA.
But that’s not the right strategy for everyone, either. It all depends on your personal situation.
“Even if there was a tax-free, guaranteed, college focused account with growth — and to date there is not — unless it is evaluated from a comprehensive perspective of the student’s and family’s overall situation, it may not even be the right thing to do, Slater said.
Now on to what 529 plan you might consider.
He said given that New Jersey doesn’t offer an income tax deduction for contributions made to its plan, you shouldn’t limit your options.
“You may want to consider the 529 plans of Michigan, Maryland, Massachusetts and New York,” Taylor said. “These plans typically have lower fees, greater breadth of investment options and managers, low initial contribution amounts and high plan maximum account values.”
Whatever plan you choose, the investment allocation of a 529 should be reviewed on at least a semiannual basis, Taylor said, and an investor will want to slowly shift the portfolio from equities to largely fixed income and money market mutual funds as the child approaches college age in order to protect principal.
Karin Price Mueller writes the Bamboozled column for The Star-Ledger and she’s the founder of NJMoneyHelp.com. Click here to sign up for the NJMoneyHelp.com weekly e-newsletter. Like NJMoneyHelp.com on Facebook and follow it on Twitter.